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March 25, 2013

Saving the Family Enterprise: How to Keep Life in an Old Firm

Generations-old family businesses in Europe, South America and Asia offer a multigenerational model, says 150-year-old Boston law firm

Hemenway & Barnes partner Fred Marx.

It’s a truism that most American family-owned businesses die off after the third generation: the founder pulls himself up by his bootstraps and his sons and daughters carry his vision into the next generation, only to see their own children bring the firm crashing down in a flood of laziness, greed and divided loyalties.

How can family enterprises in the U.S. save themselves from such a fate? By borrowing from the family business models of Europe, South America and Asia, according to Hemenway & Barnes, a Boston-based law firm that traces its origins to 1863, when it started acting as trustee to New England’s most prosperous seafaring families. Later, the firm went on to represent wealthy American families behind businesses such as Dow Jones & Co. and Jordan Marsh Co.

“You have families with benign dictators, but what you want is a republic that’s organic and based on merit,” said Hemenway & Barnes partner Frederic Marx in an interview earlier this month with AdvisorOne. “The problem with a kingmaker is when a king passes away or moves on, there may be no succession.”

Saddle Makers and Banking Brothers

As good examples of European families that have succeed in creating an organic structure, Marx pointed to Hermès Paris, which started out as a saddle maker and is now an international manufacturer of luxury goods, and the Rothschild Group, which began as a banking house of five brothers and has become one of the world’s largest independent financial advisory firms.

By setting itself up as a holding company with a major business as its principal activity, a family enterprise can then use that core business to build other businesses and diversify over the generations, Marx said. That way, when the core business goes into decline, other businesses that the family has developed along the way can replace it.

“The odds are pretty significant that a core business won’t make it to the third generation, so you need to plan for that by planting seeds and harvesting when a particular company needs to be sold. That’s how you create an organic, strong multigenerational structure,” Marx said. “The classic stockholder agreement for a will doesn’t really address the way you plan for a family as an economic force to survive over generations.”

In “Fueling the Family Enterprise,” an essay about what family businesses can gain by embracing diversification, Marx writes that America’s cultural focus on the individual “has created a mindset of dogged persistence and entrepreneurialism” that is good for single businesses but not for multigenerational family firms.

Finding Strengths Within a Family

“Family businesses in Europe, Asia and South America face similar challenges with a different cultural outlook,” Marx writes. “Their emphasis is on preserving the business as an extension of the family, with every member of the tree playing a role. This tends to result in legacies that unfold through the business and the family for many generations.”

History shows that only 30% of family businesses survive into the second generation, 12% into the third and only about 3% into the fourth or beyond, he notes.

“Consider that given average birth rates, over the course of 150 years a family can produce 450 descendants,” Marx writes. “A holding company with continuously developing subsidiaries would allow a great number of those descendants to participate in the growth and the returns.”

Marx has worked with American families to develop a multigenerational model, and each family discovers its own variations on that theme, Marx said during the phone interview.

“The process varies for every family because you have different personalities in each group,” he said. “First you sit down with family to determine their goals, then develop an entity to meet these goals. One of the big challenges is family members who are in and others who are outside the inner circle. Our model allows for creation of a structure that provides opportunties, whether for-profit or philanthropic. It’s very entrepreneurial.”

The result of such entrepreneurialism?

A powerful set of companies, according to Marx. “The 4,400 major family-owned industrial firms with revenues of more than 50 million euros accounted for 43% of all German exports in 2011,” he writes.

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